Economies of Scale Explained | Think Econ

Summary

The video script delves into the concept of economies of scale, explaining how businesses gain cost advantages as production becomes more efficient. It distinguishes between internal and external economies, illustrating how larger companies often have a competitive edge due to cost savings spread over a larger number of goods. The script uses the smartphone industry as a vivid example and touches upon the limitations of economies of scale, such as in restaurant kitchens. It concludes by emphasizing the importance of economies of scale for businesses seeking a competitive advantage and the benefits for the overall economy.

Takeaways

• 📈 Economies of scale are cost advantages that companies gain when production becomes more efficient through increased output.
• 🏭 Larger companies generally experience greater cost savings due to economies of scale, as they can spread fixed costs over a larger number of products.
• 🔍 Economies of scale can be internal, stemming from management decisions, or external, influenced by factors like labor and material costs.
• 🤖 Specialization of labor and the use of integrated technology can lead to increased output volumes and contribute to economies of scale.
• 💼 Bulk purchasing and lower borrowing costs from banks or other lenders can reduce per-unit costs, enhancing economies of scale.
• 📊 Spreading the cost of internal functions across more units produced and sold helps to lower the overall cost per unit.
• 🚀 Companies can create diseconomies of scale if they grow too large and become less efficient, as illustrated by the 'too many cooks' example in restaurant kitchens.
• 📱 The smartphone industry is highlighted as an example where large companies like Apple and Samsung benefit significantly from economies of scale.
• 🛒 Businesses can achieve economies of scale by buying in bulk, which often leads to discounted per-unit prices.
• 🛠️ Companies can realize internal economies of scale by reorganizing resources for greater efficiency, leading to larger profit margins.
• 🌐 External economies of scale can be realized by growing in size relative to competitors and using that size to negotiate better deals and practices.

Q & A

What is the definition of economies of scale?

Economies of scale refer to the cost advantages that companies attain when their production becomes more efficient, typically achieved by increasing production and lowering costs as the costs are spread over a larger number of goods.

How do companies benefit from economies of scale?

Companies benefit from economies of scale by achieving cost savings as they produce more, which allows them to spread the fixed costs over a larger number of units, thereby reducing the cost per unit.

What are the differences between internal and external economies of scale?

Internal economies of scale are based on management decisions such as accounting, information technology, and marketing, which improve efficiency within the company. External economies of scale are related to outside factors like the cost of acquiring labor or intermediate goods for production.

Why do larger companies often have a competitive advantage over smaller ones?

Larger companies often have a competitive advantage because they can produce more and spread the cost of production over a larger amount of goods, which generally results in lower per-unit costs and the ability to price products more competitively.

What are the three main reasons economies of scale lead to lower per-unit costs?

The three main reasons are: specialization of labor and integrated technology which boosts output volumes, lower per-unit costs from bulk orders and borrowing capital at lower rates, and spreading internal function costs across more units produced and sold.

Can you give an example of economies of scale in the smartphone industry?

An example is the cost difference between an individual trying to build a single smartphone versus companies like Apple or Samsung producing millions. The individual lacks the parts, manufacturing capabilities, and expertise, resulting in a much higher cost compared to the mass-produced, efficiently manufactured smartphones by these companies.

What is the concept of diseconomies of scale?

Diseconomies of scale occur when a company becomes too large and the pursuit of further economies of scale leads to decreased efficiency and increased costs, often due to management challenges or operational bottlenecks.

How can the phrase 'Too many cooks spoil the broth' relate to diseconomies of scale?

The phrase illustrates the idea that adding more resources (like cooks) beyond a certain point can lead to inefficiency and reduced output, which is similar to diseconomies of scale where increased size starts to negatively impact productivity.

How can a company realize internal economies of scale?

A company can realize internal economies of scale by reorganizing the distribution of its resources, such as equipment and personnel, to make operations more efficient, which in turn can lead to larger profit margins.

How can a company realize external economies of scale?

A company can realize external economies of scale by growing in size relative to its competitors and using that size to engage in competitive practices, such as negotiating discounts for bulk purchases.

Why are economies of scale important for businesses and investors?

Economies of scale are important because they provide businesses with a competitive advantage in their industry. Investors look for companies that can achieve economies of scale as it signals potential for growth and profitability.

Outlines

00:00

📈 Economies of Scale: The Competitive Advantage of Large Companies

This paragraph introduces the concept of economies of scale, explaining how companies achieve cost advantages as production becomes more efficient. It highlights that larger companies often have a competitive edge due to their ability to spread costs over a greater number of goods, leading to cost savings. The paragraph also differentiates between internal economies of scale, which are influenced by management decisions, and external economies, which are affected by factors outside the company. The importance of economies of scale in all industries is emphasized, as is the reason why smaller businesses might charge more for similar products. The paragraph concludes with three main reasons for lower per unit costs due to economies of scale: specialization of labor, bulk orders, and spreading internal function costs.

Keywords

💡Economies of scale

Economies of scale refer to the cost advantages companies achieve when production becomes more efficient as the scale of operation increases. This concept is central to the video, explaining how larger companies can lower per-unit costs by spreading expenses over more units of output. For instance, the video mentions that larger companies like Apple or Samsung can produce smartphones more cheaply due to their scale.

💡Cost advantages

Cost advantages are the benefits a company gains by reducing its production costs. In the video, this term is used to describe how companies can lower their costs through economies of scale, such as by buying in bulk or improving internal efficiencies. For example, the video highlights that larger companies can negotiate lower prices for bulk orders from suppliers.

💡Internal economies of scale

Internal economies of scale are cost savings that result from within the company, due to decisions like better management, technology use, and resource allocation. The video explains that internal economies of scale include improvements in accounting, IT, and marketing, which help a company reduce costs and increase efficiency.

💡External economies of scale

External economies of scale occur due to external factors, such as industry-wide cost reductions or benefits from being in a specific location. The video describes how companies can benefit from lower costs of labor or materials available in their market environment. These external factors help companies to achieve cost savings beyond their internal operations.

💡Specialization of labor

Specialization of labor refers to workers focusing on specific tasks to increase productivity and efficiency. In the video, this concept is used to explain one of the main reasons for economies of scale, as specialized labor can boost output volumes. For example, having dedicated teams for different tasks in a production process can lead to greater efficiency.

💡Bulk purchasing

Bulk purchasing involves buying large quantities of goods to obtain a lower price per unit. The video explains that larger companies can leverage their size to negotiate discounts on bulk purchases, which contributes to their economies of scale. This allows them to reduce the cost per unit and gain a competitive edge over smaller businesses.

💡Diseconomies of scale

Diseconomies of scale occur when a company becomes too large and inefficiencies arise, increasing per-unit costs. The video illustrates this with the example of a crowded restaurant kitchen where too many cooks reduce efficiency. This concept highlights the limits of economies of scale and the potential drawbacks of excessive growth.

💡Competitive advantage

A competitive advantage is an attribute that allows a company to outperform its rivals. The video discusses how economies of scale give larger companies a competitive advantage by enabling them to produce goods at a lower cost. This advantage helps them to offer lower prices or achieve higher profit margins compared to smaller competitors.

💡Production efficiency

Production efficiency refers to the ability to produce goods at the lowest possible cost while maintaining quality. In the video, this concept is linked to economies of scale, where increased production leads to cost savings and improved efficiency. Efficient production processes are crucial for companies to maximize their economies of scale.

💡Cost per unit

Cost per unit is the average cost of producing a single unit of output. The video explains that larger companies can reduce their cost per unit by spreading fixed costs over more units. This lower cost per unit is a key aspect of economies of scale, enabling companies to price their products more competitively or increase their profit margins.

Highlights

Economies of scale are cost advantages attained by companies when their production becomes more efficient.

Companies achieve economies of scale by increasing production and lowering costs, spreading costs over a larger number of goods.

The size of the business often matters, with larger companies experiencing more cost savings.

Economies of scale can be both internal, based on management decisions, and external, influenced by outside factors.

Internal economies of scale include accounting, information technology, and marketing decisions.

External economies of scale relate to the cost of acquiring labor or intermediate goods for production.

Economies of scale explain why large companies often have a competitive advantage over smaller ones.

Cost per unit depends on production volume and cost of production, allowing larger companies to charge less.

An industry's ability to dictate product costs is influenced by the production of similar goods by multiple companies.

Three main reasons for lower per unit costs due to economies of scale: specialization of labor, bulk orders, and spreading internal function costs.

Specialization of labor and integrated technology boost output volumes.

Bulk orders from suppliers and lower borrowing costs contribute to lower per unit costs.

Spreading internal function costs across more units helps reduce overall costs.

Diseconomies of scale occur when a company becomes too large and the pursuit of economies of scale backfires.

A smartphone example illustrates the cost difference between individual and mass production.

Restaurant kitchens demonstrate the limitations of economies of scale with too many cooks in a small space.

Economies of scale can be achieved through internal reorganization and external competitive practices.

Investors look for economies of scale when selecting investments, as they provide a competitive advantage.

The pursuit of economies of scale leads to increased efficiency, benefiting the economy and markets.

Transcripts

Hey everyone and welcome back to the channel.  Today we're going to be talking about a key  

microeconomic concept known as economies of  scale. With that said let's get right into it.

Alright so let's start off answering perhaps  the most important question you're wondering:  

What are economies of scale? Well, put in simple  terms, economies of scale are cost advantages  

attained by companies when their production  becomes more efficient. Companies can achieve  

economies of scale by increasing production and  lowering costs; and this is possible since the  

costs are spread over a larger number of goods.  Does that sound confusing? Allow me to explain.  

The size of the business often matters when  it comes to economies of scale. The larger the  

company, the more the cost savings. Economies of  scale can be both internal and external. Internal  

economies of scale are based on management  decisions including things like accounting,  

information technology, and marketing, while  external has to do with the outside factors  

like the cost of acquiring labor or intermediate  goods to be used in production. Economies of scale  

are an important concept for all businesses in  all industries. It explains why large companies  

oftentimes have a competitive advantage over  smaller companies. Have you ever wondered why  

a smaller business charges more for a similar or  even identical product sold by a larger company?  

That's because the cost per unit depends on how  much the company produces as well as how much  

it costs them to produce. Larger companies can  produce more by spreading the cost of production  

over a larger amount of goods. An industry may  also be able to dictate the cost of a product if  

several different companies are producing similar  goods within the industry. Now there are three  

main reasons why economies of scale have led to  lower per unit costs. First, specialization of  

labor and more integrated technology boosts output  volumes. Second, lower per unit costs can come  

from bulk orders from suppliers as well as lower  costs of borrowing capital from banks or other  

loan providers. Third, spreading internal function  costs across more units produced and sold helps to  

reduce costs. A company can create a diseconomy  of scale when it becomes too large and chases an  

economy of scale, but we'll give an example of  that in just a second. As a dramatic example of  

economies of scale think of a smartphone. How much  money do you think it would cost for you, yes you,  

the person watching this video right now, to build  a single smartphone all by yourself? Well after  

considering the cost of hardware, materials, and  the knowledge you'll need to achieve such a feat,  

I'm willing to bet the cost is somewhere in the  ballpark of quite a lot of money. Definitely more  

than the five to six hundred dollar range that  it costs Apple or Samsung. But why does it cost  

you so much more to make? Well in this example  it's quite obvious. You don't have the parts,  

the manufacturing capabilities, and likely the  expertise to make smartphones as efficiently  

as these companies do. So while they're pumping  out hundreds of millions of smartphones each year  

and raking in a hefty profit per individual phone  you're probably in debt just from creating one all  

by yourself. What about dis economies of scale?  Restaurant kitchens are often used to illustrate  

how economies of scale are limited. More cooks in  a small space get in each other's way and become  

less efficient. This is the case even though  intuitively more cooks should equal more output.  

Have you ever heard of the phrase "Too many cooks  spoils the broth"? Well this is more or less what  

that saying is getting at. Economies of scale are  advantages that sometimes occur as a result of  

increasing the size of a business. For example,  a business might enjoy an economy of scale  

concerning its bulk purchasing. By buying a larger  number of products at once it could negotiate  

a lower per unit price than its competitors as  buying in bulk often results in a discounted price  

per unit. Put simply, economies of scale can be  achieved in two ways: first, a company can realize  

internal economies of scale by reorganizing  the way their resources such as equipment and  

personnel are distributed within the company. That  is, making the company more internally efficient  

results in larger profit margins. Second, a  company can realize external economies of scale  

by growing in size relative to their competitors  and then using that increased size to engage  

in competitive practices such as negotiating  discounts for bulk purchases. Economies of scale  

are important because they help provide businesses  with a competitive advantage in their industry.  

Companies will therefore try to realize economies  of scale whenever possible just as investors will  

try to identify economies of scale when selecting  investments. This will lead to companies striving  

to become more and more efficient which is  generally good for the economy and the markets  

as a whole. We hope that this video helped you  to understand the concept of economies of scale.  

If you enjoyed the video be sure to let us know  by liking the video, subscribing to the channel,  

and commenting what sort of economic topics  or homework questions you'd like to see us  

cover in the future. Thanks for watching  this video and we'll catch you in the next.